Investment Matters

Company Profit Reporting season ramps up

This week reporting season got materially busier.  Nine of your equity portfolio investments released their results.

Centuria Industrial REIT

Centuria Industrial REIT (CIP)'s earnings were in line with expectations.  Underlying earnings and distribution per security were both 20.5 cents per security.  Net tangible assets per security increased marginally (1.3%) to $2.35, as compared to 30-Jun-16.

Gearing is comfortable at 43.1%, with a newly established debt facility in place.  Portfolio metrics remain sound, with 92.1% occupancy and an average lease expiry of 4.4 years.

Centuria provided FY-18 guidance for underlying earnings of between 19.5 cents and 20.0 cents per security.  Furthermore, distribution guidance was provided of 19.4 cents per security.  [At the current security price of $2.49, this is a yield of 7.8%.]  This is a small decline on FY-17 and represents tougher economic conditions, as well as increasing interest costs.

Challenger

As we have come to expect from Challenger, it was another strong result showing good revenue growth.  This was based on a growing business, and it translated into an increase in both profit and dividends.  Overall, normalised profit, normalised EPS, and dividends were all up over 6%, as compared to FY-16. (Normalised takes out the impact of market movements, as annuity proceeds are invested in markets: mostly fixed interest, to a lesser extent property, and to a small extent equities, infrastructure and other.)  Assets under management now total $70 billion, an increase of 17% compared to FY-16.

The company's main division, Life (annuities) achieved a 20% increase in annuity sales.  Furthermore, an increasing portion of these sales is for longer duration products.  This is a strong result and will contribute to future earnings growth.  Earnings from the Life division increased 6.3% in FY-17.

This smaller Funds division also performed well.  97% of Funds Under Management (FUM) of the boutique house of funds (Fidente) exceeded their benchmark over 5 years.  FUM increased 18%, and earnings increased 20.6%.

Challenger also announced a step up in the relationship it has with the Japanese insurer MS&AD.  Last October Challenger announced it had entered an agreement to sell AUD denominated annuities in Japan through MS&AD bancassurance channels.  It has been successful, with 15% of Challenger's FY-17 annuity sales being to Japan.  This has now been extended to broaden the access to the Japanese market, and Challenger will establish an office in Toyko.  The step up will also involve a $500m equity raising to MS&AD, equating to a 6.3% ownership of Challenger.  It was done at a premium to the share price (30 business day VWAP, 14-Aug-17).  MS&AD have advised they intend to increase their shareholding to 10% over the coming year, through on-market purchases.  We view this development positively, as it speaks to the opportunity that Challenger has to grow, including in Japan, and it gives them significant capital with which to do so.

In relation to the FY-18 outlook, Challenger has provided profit guidance (normalised) between $545m and $565m : 8% to 12% higher than FY-17.

Aveo

Aveo's results for the FY-17 year were slightly ahead of expectations.

Underlying profit increased 22%, which equated to 11% on a per share basis (because of the equity raising to support the RVG and Freedom acquisitions).  Return on assets (RoA) was 6.0%, within the FY-17 target range. 

The Retirement division increased earnings 26%, with the original Aveo business performing well and assistance from the Freedom and RVG acquisitions.  Contribution from development (new retirement units) also increased, including delivery of 266 new units.   Care and support services are a very small contributor to earnings, however, they did decline due to roll-out costs.

The wind down of Aveo's Non-Retirement business continued in FY-17.  Non-retirement assets are now only 13% of Aveo's total assets.  Earnings actually increased in FY-17, as land lot sales (higher margin than built product) increased as a proportion of built product sales.

We have mentioned the Aveo Way contract before; a simplified and more standardised contract that Aveo rolled out around 3 years ago.  Aveo made a significant number of announcements this week - with the notable ones being to simplify contracts further, offering money back guarantees and shorter buyback periods, strengthening of complaints and incident handling procedures, and implementation of all eight resolutions raised by the peak industry body (the Property Council of Australia's Retirement Living Council).

Looking to the future, the way Aveo presents itself and communicates with the market indicates it is very much on the front foot and leading the industry.  In relation to the impact of recent negative media coverage, inquiry rates for July were ~60% below those at Jul-16.  However, they are now increasing, with better quality of inquiry (more informed potential residents with genuine interest).  It appears therefore, that the impact is likely to be meaningfully less than some potentially feared.

For the financial outlook, Aveo is forecasting earnings per security of 20.4 cents, a 7.9% increase as compared to FY-17.  Aveo remains on track to achieve a RoA for FY-18 between 7.5% and 8.0% (some media reporting indicates Aveo is earning excessive profits; this figure confirms that actually, Aveo is heading towards what would be considered a reasonable [but not excessive!] level of return for security holders).

 

Origin Energy

Origin Energy released a result ahead of most expectations, including those of your Investment team. 

As was flagged last week in Investment Matters, there was a significant write-down.  This flowed through to the statutory numbers.

On an underlying basis, however, earnings grew strongly on the back of higher wholesale electricity prices and the higher oil price, and underlying profit increased $185m over FY-16 to be at $550m for the year.

Integrated Gas, which includes Origin's share of APLNG, Lattice Energy (upstream oil and gas exploration company) and other exploration and development assets (e.g. in the Surat and Browse basins), increased EBITDA (earnings before interest, tax, depreciation and amortisation) by 186% to $1,104m.  This was driven mainly by increases in both volumes of production and the price realised for LNG production. 

Energy Markets, energy retailing and electricity generator, increased EBITDA 12.2% to $1,492m.  Wholesale electricity prices were the main driver of this.

Net debt decreased to $8.1 billion - $1 billion lower than it was on 30-Jun-16, using the proceeds of asset sales.  However, because of the asset write-down, gearing has increased.  As expected, a dividend won't be paid until the debt level is lower.

In relation to the outlook, the company is expecting earnings to grow in FY-18, driven by growth in energy markets and integrated gas.  More specifically earnings of the Energy Markets division is expected to increase 14-21% on FY-17, driven by electricity prices and a stable natural gas contribution.  Additionally, LNG production is expected to be 7-16% higher than FY-17.  The debt will reduce to less than $7 billion following the Lattice divestment (expected in the second half of this calendar year).  We view this outlook positively.

Pact Group

Pact released an acceptable result - noting that tough economic conditions continue to impact the company's operations.

Underlying profit (excluding acquisition costs and the start-up costs of the Woolworths crate pooling contract) was $94.4m - up 7.4% as compared to FY-16.   Contributions from acquisitions drove the growth, which was partially offset by volume reductions, and to a lesser extent, margin pressures.

Good operating cash flow and a reduction in gearing were achieved.  The dividend increased almost 9% as compared to FY-16 and represents a yield of 4.2%, or 6.0% including franking.

The company expects to achieve higher underlying revenue and earnings in FY-18 (subject to economic conditions).

QBE Insurance

QBE released a result ahead of our expectations - but somewhat surprisingly it wasn't that well received by the market.  (We suspect because of the short term impact of the emerging markets division, rather than a focus on the bigger picture.)  QBE's result is for the half year ending 30-Jun-17 (FY = CY).

Key metrics showed positive trends with 3% growth in gross written premium (constant currency), expense ratio declining from 16.1% to 15.2%, COR (combined operating ratio, <100% = profitable underwriting) at an acceptable level of 95.3% (was 94.5%), and the insurance margin increased from 5.6% to 9.3%.  Cash profit increased 30% to $374m.

QBE's Australia/NZ division performed well and has been able to put through price increases.  Conditions are tough in Europe - some parts more than others - but nevertheless a good result was achieved.  North America (principally the USA) delivered profitable underwriting, with an improving performance trend. 

The smaller Emerging Markets division was a significant miss.  Flooding related claims in Chile, property and marine related claims in the Asia Pacific, Brazil travel, large fire claims in Mexico, and adverse reserve movements for Hong Kong worker's compensation were identified as factors impacting the result.  In response, QBE is going to split the Emerging Markets division into two - Asia Pacific and Latin America put in new management, tighten governance (including risk assessment), along with other measures.

The company's capital position remains very strong, with the core measure being 1.7x that required by APRA (Australia's financial regulator).  Investment performance strengthened, with 1.83% return generated for the half year, and we look forward to this growing and making an additional contribution to profits in coming periods.  The dividend increased 5%, to 22 cents per share.  The company's outlook for the remainder of the year was positive.

360 Capital

360 Capital sold its fund's management business and co-investments (including the industrial and office fund) to Centuria in Jan-17.  The financial results as detailed below were significantly impacted by this transaction.

360 Capital reiterated that its ongoing business is threefold:

  1. manager of, and co-investor in, the 360 Capital Total Return Fund (TOT)

  2. investing private capital in property investments (which includes an investment in the Asia Pacific Data Center REIT), and

  3. debt financing - providing alternative (non-bank) lending and structured financing solutions to Australian real estate investors and developers

NTA (net tangible assets) at 30-Jun-17 was $0.95 cents per security (as compared to $0.68 at 30-Jun-16).  A significant portion of these assets is cash, at $97.2m, with a further $64.1m in listed securities and $58.3m in unlisted funds.

Base earnings - assuming no further deployment of capital - is forecast to be 3.0 cents per security for FY-18.  100% of these earnings will be paid to security holders as distributions.

 

Primary Health Care

Primary's result was slightly above our expectations.  We are seeing a company, both in relation to the numbers and the commentary (for instance, in relation to GP attraction and retention), that if it hasn't turned the corner already, is close to doing so.

Repositioning of the largest division, Medical Centres, impacted financial performance.  Revenue fell slightly, but profit was down 31%, as significant investments were made.  This included doctor and health care specialist recruitment, and expanding the service offering (dental, occupational health, chronic care, IVF).  GP numbers (FTE) increased from 920 to 959, with recruitment momentum increasing.  Retention improved to 92%.  This is positive, given that GP recruitment and retention are important drivers of future growth.

The Pathology division achieved above-market revenue growth of 4.4%.  Profit increased 1.0%, with property related costs and higher cost of consumables and genetic tests impacting margins.

The Imaging division grew revenue 2.0% and increased earnings by 29.5%. Many measures contributed to the increase in margin, including the closure of uneconomic sites, focus on higher-margin tests, growth in referrals from Medical Centres, and containment of labour cost growth.

The company also delivered strong growth in free cash flow, capital spending has a disciplined focus, and debt was reduced by $36m.  The dividend was paid under the company's new dividend policy (60% of underlying profit).

Centuria Metropolitan REIT

Centuria Metropolitan REIT (CMA)'s earnings were at the top end of the guidance.  Underlying earnings and distribution per security were both 19.0 and 17.5 cents per security respectively.  Net tangible assets per security increased 6.4% to $2.32, as compared to 30-Jun-16.

Gearing is conservative at 29.5% (and 27.4% post the capital raising conducted in Jul-17, which also assisted with acquisitions).  Portfolio metrics remain sound, with 97.3% occupancy and an average lease expiry of 3.9 years as at 30-Jun-17 (which have strengthened subsequently).

Centuria provided FY-18 guidance for underlying earnings of 18.6 cents per security.  Furthermore, distribution guidance was provided of 18.1 cents per security.  [At the current security price of $2.39, this is a yield of 7.6%.]  The underlying earnings guidance is a small decline on FY-17 and represents tougher economic conditions.